Yellen on the Economic Outlook (Oct 9, 2007)

Earlier this week, Janet Yellen, President of the San Francisco Fed, gave a speech on "Recent Financial Developments and the U.S. Economic Outlook." Yellen is one of the most informative and articulate Fed speakers; I'd highly recommend putting all her speeches on your reading list. This speech covers lots of ground, but there are three points I want to highlight.

On recent economic performance:

Recent data on personal consumption expenditures have been robust. Manufacturing output and orders for core capital goods have been upbeat, and business investment in equipment and software promises to be a bright spot. Despite the hike in borrowing costs for higher-risk corporate borrowers and the illiquidity in markets for collateralized loan obligations, it appears that financing for capital spending for most firms remains readily available on terms that have been little affected by the recent financial turmoil.... That said, most of these data are too early to reflect the effects of the financial turmoil, and those effects are more likely to show up in data for the current quarter.

Translation: We're not paying too much attention to Q3 indicators; you shouldn't either.

On housing and employment:

"The downturn in house prices would likely be intensified by a simultaneous decline in employment, should that occur, since significant job loss would weaken demand for housing and raise foreclosures."

"Should the decline in house prices occur in the context of rising unemployment, the risks could be significant."

Translation: The Fed will act very aggressively to counter any signs of increasing unemployment.


On inflation and the Fed funds rate:

Turning to inflation, signs of improvement in underlying inflationary pressures are evident in recent data. Over the past twelve months...the core PCE price index, has increased by 1.8 percent. Just several months ago, the twelve-month change was quite a bit higher, at nearly 2½ percent. It wouldn’t surprise me if core PCE price inflation edged down a little bit more over the next few years.

...the stance of monetary policy before the September meeting was probably a bit on the restrictive side.... In fact, the stance of policy was growing more restrictive as core inflation gradually trended down.

Translation: Pay attention to real interest rates. Even after the 50bp cut, the real fed funds rate is still higher than it was at the beginning of the year.

This last point by itself argues pretty strongly for another 25bp cut on Oct 31.